Steady As She Goes

01/04/2010 12:30 pm EST

Focus: MARKETS

James Stack

President, Stack Financial Management

Jim Stack, president of Stack Financial Management and editor of InvesTech Research, says the big early gains are over, but the bull market will continue in 2010.

As we look back at the past 12 months, this has indeed been a volatile period for the stock market. Yet from a performance standpoint, it has actually turned out to be a good year—a very good year!

With all the volatility, this has not been an easy year to navigate! The market rebounded sharply off the March low, yet psychologically, this shift in focus away from a bear market defense was difficult for most investors. The economy was mired deep in a recession and unemployment was rising with no end in sight.

While new bull markets always climb a wall of worry, this one was particularly formidable. It’s no surprise that many investors, and even professionals, remained on the sidelines.

We faced some tough decisions in increasing allocation last spring. Now, as we approach year end, the InvesTech Model Portfolio is up about 24% year to date—which is in line with gains in the major market averages, but with far less volatility. Most important, our portfolio has fully recovered 100% of its bear market losses.

As one might expect, the rally off the market bottom was led by speculation in battered financial stocks. Since the March 9th low, the financial sector has gained a whopping 131% [despite] increasing bank failures and unrelenting credit market troubles. That’s hardly a full recovery, as this sector is still down 60% from its peak.

Other traditional early bull market sectors—including consumer discretionary, industrials, materials, and information technology—have also outperformed the index over the last nine months.

Expect 2010 to be less volatile, but every bit as challenging and definitely more selective. The economy is stabilizing, but the recovery is not robust. And, as demonstrated by the recent Dubai credit problems, there are still residual risks in the global credit markets.

Also, the massive US stimulus has opened the door to rising deficits, a falling dollar, and potential inflation. Nonetheless, this bull market still deserves every benefit of doubt as we navigate a fragile, but developing, recovery.

Our recommended plan of action at this point remains unchanged:

  • Use a safety-first strategy, which includes maintaining a balance between higher- growth or cyclical companies and core defensive stocks or sectors.
  • Any additions or changes should focus on value. Look for companies with strong financial pictures, good growth opportunities and attractive valuations.
  • Continue to avoid areas of higher risk, including financials and mortgage-related investments. These have rallied strongly off deeply depressed levels, but they are still vulnerable.

While we remain vigilant for any warning flags that would dictate a move to a more defensive position, the technical and fundamental picture at this stage is stable, and changes to the portfolio will likely be minor sector or allocation adjustments.

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